Beazer Homes USA Inc (BZH) 2013 Q4 法說會逐字稿

Good morning. And welcome to the Beazer Homes earnings conference call for the quarter ended September 30th, 2013. Today's call is being recorded and a replay will be available on the company's website later today. In addition, PowerPoint slides intended to accompany this call are available on the Investor Relations section of the company's website at beazer.com.

At this point, I will turn the call over to Carey Phelps, Director of Investor Relations. Ms. Phelps, you may begin.

Thank you. Good morning and welcome to the Beazer Homes conference call discussing our results for the fourth quarter and full year fiscal 2013. Before we begin, you should be aware that during this call we will be making forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors which are described in our SEC filings, including our Form 10-K, which may cause actual results to differ materially. Any forward-looking statements speaks only as of the date on which statement is made, and except as required by law, we do not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. New factors emerge from time to time and it is not possible for management to predict all such factors.

Joining me today are Allan Merrill or President and Chief Executive Officer, and Bob Salomon, our Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will take questions in the time remaining. I will now turn the call over to Allan.

Thank you, Carey and thank you for joining us. 2013 was an important year for us. We exceeded virtually every one of our operational and financial targets as we positioned the company for significant growth in the years ahead. The success of our Path to Profitability strategies was magnified by our recovery in both consumer demand and home prices, allowing us to reach our profitability target far sooner than we had originally expected.

On the call this morning I'll summarize the highlights of both the fourth quarter and the fiscal year, as well as the progression of improvements in our Path to Profitability metrics that have made such a big difference in our results over the past two years. At that point, I will turn the call over to Bob. He is going to walk you through our land spending and our estimates for future community counts, which is one area where we know we still have a lot of work to do. After he's done I'm going to reset our longer-term financial targets and share our expectations for fiscal 2014 before we open the call for your questions.

Starting with the quarter's results. We generated positive net income of $11.9 million for the fourth quarter, making us profitable for both the three and six month periods ended September 30th. This is the first time we have been profitable from operations in any six month period since 2006. For the quarter we increased adjusted EBITDA to $41.5 million from $15.1 million last year, grew orders by 7% and closings by 3%, despite a headwind of a 17% decline in average community count.

We improved sales per community per month to three compared with 2.3 last year and decreased our cancellation rate by 720 basis points. We also expanded gross margins by 420 basis points to 21.4% and posted SG&A costs of 12.3% of revenues including some costs related to legacy warranty matters, which added several million dollars to G&A in the quarter.

Finally, we ended September with $505 million in unrestricted cash, we spent $161 million on land and land development compared to only $45 million in the fourth quarter of last year and we refinanced our cash secure term loan, freeing up $200 million which has been targeted for future land purchases in support of our growth aspirations.

Our full years results also reflect significant improvement from last year. Specifically, we improved our adjusted EBITDA to $86 million, nearly four times the amount we reported last year. This allowed us to narrow our profitability gap by over $100 million to just under $34 million.

We grew closings by 14.2%, with ASPs that were 12.5% above last year. Sales per community improved to 2.9 per month versus 2.3 last year. And we reduced our full year cancellation rate by 540 basis points. Gross margins were 230 basis points higher at 20%, a full year sooner than we had anticipated getting gross margins to start with a two. And finally, for the full year, we investigated $475 million in land and land development compared to only $186 million last year.

The profit we recorded for the fourth quarter was over two years in the making, dating back to when we adopted and implemented our Path to Profitability strategies. Of course, the improvement in our metrics didn't happen by themselves. The metrics got better because an energized group of people, many of whom were newly recruited to the company, acted with great focus, intensity and accountability to make the changes necessary to improve our performance. We haven't been sitting around waiting for the market to improve.

So let's take a deeper look at the results we have achieved using Q3 fiscal 2011 as our starting point. Sharpening our focus to measure and improve the performance of every community by analyzing our product, marketing, pricing, sales and production practices has paid big dividends. Sales per community per month has improved dramatically from 1.7 back in 2011 to 2.9 for fiscal 2013. And importantly, this was accomplished along side a significant ASP expansion. We had an ASP of $253,000 for the year, up around $30,000 from 2011. Even better our ASP was $263,000 in the fourth quarter and $279,000 in backlog, Providing evidence that we should see further increases in our average sales prices in the quarters ahead.

As I pointed out earlier, among the highlights for the year was getting our gross margin percentage out of the teens and into the twos, reaching a full year level that we expect to build on in the coming year. And with both prices and margins up substantially, gross profit dollars rose to $50,000 per home closed for fiscal year 2013. This pairs foreclosures gross profit dollars in the mid-$30,000 range when we launched our Path to Profitability plan.

Now let's look at the cost side of the equation. Our SG&A is down materially over the past couple of years and we have shown this two ways. First, you can see that we have improved our SG&A as a percentage of revenues from a whopping 25% a little over two years ago to 13.5% in fiscal 2013. That's still a bit high but clearly we have made a lot of progress.

The other chart looks at the same information a bit differently. While we would love to be the outright leader in every financial category compared to our peers, we have to be realistic about the role average selling prices play in the SG&A ratio. As a result, we also look at SG&A dollars per closing to come up with a per unit overhead number. For fiscal 2013, our SG&A costs were $34,000 per closing which compares very favorably to our peers.

Ultimately, our operational initiatives and improved metrics only matter if they are leading us up the Path to Profitability. And the good news is, this they are. Over the past couple of years, adjusted EBITDA has climbed significantly, from a loss of $29 million before we launched our Path to Profitability to a positive $86 million for fiscal 2013 representing a trajectory we are pleased with and intend to work diligently to continue.

With that overview of the highlights and the progression of our Path to Profitability improvements, let me pass the call over to Bob.

Thanks, Allan. As you probably have noticed, Allan got do cover all the fun stuff, point out the tremendous improvements we've made on most of our operational and financial metrics. I saw most because there is one key metric we have yet to make progress, and that is growing our community count. Gradually growing our community count was always part of the Path to Profitability, but we waited to start buying land until two things happened.

First, we wanted to demonstrate that we could operate our existing communities more successfully before going on a buying binge. And second we close to raise equity in 2012 to provide the growth capital. As part of that fundraising we told investors it would take some time to intelligently deploy the capital and then additional time before we had sales and closings to show for it.

So with that as a backdrop let's talk about our land spending and anticipated future community counts. Our operational improvement in sales per community, coupled with the latency associated with turning land spending into active communities, has contributed to a sharp reduction in community counts over the past two years. In fact, we ended the year a bit lower than we expected, at 135 average active communities in Q4.

But help is on the way. As planned, we dramatically ramped up land spending in 2013 to $475 million, up about $300 million from the prior year. And that doesn't factor in the additional land positions that we control through land banking relationships. These land banking partners have purchased or committed to purchase land parcels totalling in excess of $120 million, which will be available to us to let option take downs in the quarters ahead.

While the increase in land spending hasn't led to community count growth yet, it can be clearly seen in two ways. Inventory on the balance sheet and total lots owned and controlled. Inventory grew to $1.3 billion at the end of fiscal 2013, up $200 million in the past year, and marking the first time that inventory has grown materially since 2006. This growth in inventory is also likely to have a near term positive impact on our income statement in fiscal 2014, as we expect to capture a larger portion of our interest expense, reducing the P&L impact of interest until home closings occur on the newly acquired land.

In terms of total lots owned and controlled, at end of the fiscal 2013 we had 28,000 lots under control, up 16% from the end of last year. This included over 21,000 lots that were either active, under development or under option. In other words, either available immediately or in the near-term.

Before we provide an estimate for community count growth in fiscal 2014, we need to give you the building blocks so you can understand why we're confident in the answer even if we prove to be a bit imprecise in the timing. We ended the year on September 30th with 134 active communities but we also had 62 communities in various stages of development that were not yet open and 23 communities that had been approved but whose acquisition transactions had not yet closed. We improved another seven communities during October and have 30 plus communities that are in active negotiations around the country.

While some of these deals will fall by the wayside, others will likely a merge that we aren't yet counting on. In recent months the frenzy for land deals has subsided in many of our markets, making the opportunity for acquisitions somewhat less competitive. While we don't plan to become any more aggressive than we have been, I think more deals may work for us if fewer other builders are chasing the same opportunities. All told we are planning to spend between $500 million and $600 million on land and land development in fiscal 2014. And that's before taking into account additional commitments from our land banking partners.

While I wish we could guarantee the exact number of land acquisitions we will complete, as well as our closing dates and development schedules, we just can't do it. Unlike home construction cycle times which could be accurately measured in days or even hours, land development schedules can only be estimated, typically in weeks, as site conditions, weather, equipment availability and municipal resources all impact the ultimate completion date.

Based on what we know today, here are our estimates of expected average active community counts during fiscal 2014. We will look at this both sequentially and on a year-over-year basis. First, sequentially. We expect Q1 to be essentially flat in average active community counts to where we ended fiscal 2013. Then we expect Q2, Q3 and Q4 to be up about 5% each on a sequential basis.

Looking at our year-over-year estimates; we expect that Q1's average community count will be down about 10% compared to last year and Q2 will be down about 5%. With new community openings expected to outpace close-outs in our spring selling season, Q3 should be up about 5% and in Q4 should be up nearly 20% year-over-year on a quarterly average basis. The corresponding expected community count ranges for each quarter have also been included on this slide.

We will likely end the year with around 160 active communities, slightly below the estimate we provided in August, as we have decided to sell off a handful of lot positions within our larger acquisitions, both to recycle cash and to enable us to trade for incremental communities with other builders. The benefits of any trades are not yet reflected in projections I have provided. The bottom-line is simple; our community counts will soon start growing, removing the one nagging impediment that has held us back in recent years.

With that and in the interest of time, I'm going to turn the call back over to Allan. However, if you're interested in seeing some of the other slides that we typically use in our earnings calls, they are available in the appendix to this presentation.

All right. Thanks, Bob. Despite some softening in demand in recent months, the fundamentals for the home building industry remain favorable. While home buyers are having to adjust to the prospects of higher monthly payments in light of higher home prices and higher mortgage rates, new homeownership still provides quite value compared to renting and in relation to incomes. Fundamentally, I believe we are in the midst of a multi-year recovery period. And although temporary hiccups are possible, either due to housing policy changes, general economic concerns or other factors, affordability in most of our markets remains strong and inventories of new and used homes are low. Both of these factors provide us with a measure of confidence that new home prices and single family starts will continue to grow in the years ahead.

As I said at the outset, 2013 represented an important turning point for the company. We reached a key milestone in the fourth quarter when we reported our first profit from operations since 2006. And we fully expect to be profitable for the full year of fiscal 2014. While that is great news for our shareholders, our bondholders, our trade partners and for our employees, it creates a new challenge for us. After all, getting to profitability was always an interim objective, not the long-term best case scenario.

For that reason we've decided it is time to share our next multi-year financial objective, as well as the metrics by which our progress can be measured. In simple terms, we've replaced the Path to Profitability with a new objective with its own catchy acronym, 2B-10. It stands for reaching $2 billion in revenue with an EBITDA margin of at least 10%. Like the Path to Profitability, it won't happen in a single year. But also like the Path to Profitability, we expect to make consistent progress toward this new goal until we can raise it even higher.

So what has to happen for us to reach $2 billion in revenue with a 10% EBITDA margin? Obviously, there are lots of different combinations that can get us there, but to keep things simple, we will provide some fixed targets for the plan. As markets change, we will likely reach the goal somewhat differently. But for now, this as reasonable way to think about how we can achieve 2B-10. On the revenue side, we are targeting about 175 average active communities, 3.2 sales per community per month, assuming for simplicity sake, that sales and closings converge, and an ASP of about $300,000. Reaching those targets would result in $2 billion in revenue. From where we started two years ago, this would have seem impossible, if not somewhat delusional. Today I think it represents an excellent 24 to 36 month goal.

On the cost side, we need to continue to improve gross margins and leverage our overheads. Specifically, we are targeting at least 22% homebuilding gross margins and SG&A as a percentage of revenue of 12% or less. Taken together, these improvements would create a 10% EBITDA margin. And like the revenue goal, they seem to us to be well within reach in the coming two to three years. Our newer communities should be accretive to gross margins even without much price appreciation in the market and we've demonstrated we can get excellent overhead expense leverage out of any revenue growth.

While we expect to take more than one year to reach the full $2 billion in revenue and the 10% EBITDA margin, I know you're interested in what we expect to accomplish in fiscal 2014. First, on the revenue side, we expect to end the year with about 160 active communities or up nearly 20% at the year end, with a full year average community count of around 150. We expect to sell approximately three homes per community per month or just a bit higher than we achieved last year. And we expect ASPs of between $275,000 and $285,000, up around 10% from fiscal year 2013, exclusively driven by mix because we don't count on price appreciation in our forecast.

Turning to the margin side, we expect to improve gross margins to somewhere between 21% and 22% for the full year, allowing us to achieve gross profit dollars per closing of around $60,000. And we believe we can reduce SG&A by another 50 to 100 basis points to 12.5% to 13%. Together our performance in both the revenue and margin metrics should translates into at least mid-teen revenue growth and should add more than $30 million in adjusted EBITDA, representing at least 35% growth. In other words, we expect to make a pretty big leap toward 2B-10 this year, even though unit activity isn't likely to be very much higher.

Finally we would be remiss not to remind you that upon achieving sustainable profitability, we will be able to remove the valuation allowance that hides our deferred assets from plain view. The slide in the appendix contains the details but this is worth an estimated $12 to $14 per share in book value once our DTA is back on-blance sheet.

I'm very proud of the progress our team has made in two shorts years. Operationally, we're now positioned for both revenue and profit growth in the coming years, allowing us to fully participate in the gradual housing recovery. By providing both our multi-year 2B-10 targets and our expectations for fiscal 2014, we hope to help investors better understand the value creation opportunity that is still in front of us. Thanks for joining us on the call today. Operator, would you please take us to Q&A?

Yes. Thank you. (Operator Instructions). Our first question does come from Ivy Zelman of Zelman & Associates. Your line is open.

Thank you. Good morning, guys. Congratulations on a great quarter. Now, you gave us a lot of good information, Allan, on your outlook and your expectations. Can you just dig down a little bit more into the current trends? And maybe talk a little bit what you saw in October traffic? Orders came in better than we were expecting. And are we starting to finally see the consumer coming back after the sluggish months throughout the summer? Are you feeling more optimistic in some of the activities you have recently been experiencing? And, obviously -- your sales per community were stronger than many of the other builders in the market. So I don't know if that's concession a little bit driven or just give us some color, please.

Sure. Let me talk about the fourth quarter and then I will make a short comment about October. The fourth quarter started flattish, July didn't feel very good, didn't feel terrible. But it wasn't what we were hoping for. And then August was really not very good. We got a couple of weeks into August and it felt like this slowdown, this seasonal issue that is normal had been exacerbated by what people have called payment shock or sticker shock. And we decided to do something about it. So we put our heads together and we repackaged in every community the incentives that we were offering and got very promotional in September.

Now, I say that -- we didn't actually make big in the economics of our transactions, but we repackaged things. Instead of stainless steel appliances, it was granite countertops, instead of a flooring package, maybe it was an upgraded bathroom. But really trying to target specific opportunities at each community. And I have to say that the results of that freshening up of our selling activity really beat our expectations in September. We had a terrific September. So on balance, the quarter ended up a little bit better than we might have hoped for, but I think it's because we got pretty aggressive in our marketing proposition. But not so aggressive on what I would call margin killers. Was it $100 here or $400 there? I'm sure it was, but it was really not a capitulation quarter where we tried to drive sales, margins be damned.

In October, I'm pleased that we've got 16 divisions, 13 of our divisions were kind of at their planned level for October. Three are a little bit behind. But on balance we feel okay, cautious. This time of year there are a couple of things going on. We have the normal seasonality that everybody has. But one thing we in particular want to be careful of is we kind of want to keep our head down, because this is when many of our peers have their fiscal year ends. And a lot of them have steep backlogs or units that they want to closeout, generate the cash, make the profits. And more power to them.

But what we've coached our teams to not do is to chase pricing and incentives on finished specs that others are selling for fiscal year-end reasons with a to-be-built with our incentive package. So we are going to be kind of cautious this quarter and don't expect to chase activity. It's a normal seasonal thing for us and it's exacerbated by this mismatch of fiscal year end with most of our peers.

On the traffic side and this would have been true really through the fourth quarter and into October, there's sort of a tale of two cities. Our traffic is up a bill bit, but our community count has been down so much that our traffic per community, which is really I think the most important metric, has been up around 30% in recent months. So traffic levels have stayed pretty good and have been improved year-over-year. So that's a little color on traffic, a little color on October and hopefully something responsive about Q4.

No. Excellent and very helpful, Allan. And just one more on a follow-up. With respect to being more promotional, admittedly not the margin killers you highlighted. It seems as if that promotional activity in some other builders' cases really didn't work. Maybe just the way they went about it. But it would appear that the consumers looking for some value. And maybe why there -- maybe to explain their hesitancy, its with home prices up as much as they are over the last year and one-half and with the mortgage rates rising, do you feel that that type of impediment is really about their perception that they're not getting good value? Or is it rates have fallen and by giving them some type of a discount that it's making it more affordable for them? So just to clarify; is it affordability or is it their perception of value? And then I will go back in the queue. Thank you.

I think it's perception, Ivy. I really don't think it's affordability. I think it's psychology and perception. There's no question that if you were looking at pricing a new home in the fourth quarter and looking at that monthly payment, it was a lot higher than it had been six or 12 months before. And so there's kind of a schmuck factor, where the buyer says, gosh, this doesn't feel very good. But when you have the longer discussion with the buyer, and in that period of time they were longer discussions, and you ask them do you think interest rates are directionally over time headed higher or lower? And do you think home prices directionally are headed higher or lower? And they kind of get themselves around the fact to that this is an adjustment they need to make.

And then our discussion has been around, where are monthly payments in relation to rents? And where are they in relation to incomes? Because to the extent that they're up, that's a factor. But to the extent that they're still at attractive levels of income, that's a better factor. And to the extent that it's less expensive to be an owner on a pre-tax basis than to be a renter, that's even better. So that I think that's really the discussion.

And I will tell you I was incredibly gratified -- one of our new home counselors said to me in September and it was like the light bulb had done off with her. She said, it doesn't help to throw money at the problem. They need to feel good about the purchase decision they're making and actually increasing cash incentives wouldn't work. From her lips to God's ears. But I have to say I was encouraged by that and that really governed how we behaved in the quarter.

Well, we really appreciate it. Thanks again and congratulations on the quarter.

Thanks Ivy.

Our next question does come from Michael Rehaut at JPMorgan. Your line is open.

Thanks. Good morning and congrats on the quarter. Just to quickly clarify from your response to Ivy's question about repackaging incentives and getting a little more aggressive in marketing, and combining that with comments that you don't expect them really to be margin killers, roughly similar economics. You also gave the guidance for 20% to 21% gross margin in fiscal 2014 off of 20% in 2013. So are we to perfect kind of a gradual or consistent margin expansion the year? And that is also based on even what you have done in September?

So thanks for asking, Mike. That's a good question. I think one of the things that we struggle with, and I haven't been very good at historically on these calls, is trying to articulate that the complexity of sequential margins and year-over-year margins. And one of the things I did, and this is going to make people's heads explode. You won't want to hear it, but I'm going to do it in anyway. We went back and I analyzed what the change in margins quarter-to-quarter was over the last four or five years. And what's amazing, both up and down, the average change sequentially in gross margins for our company has been about 1.8%. So to say that it has been volatile period-to-period is an understatement.

And trying to understand that and understand the mix, the geography and the buyer profile mix that sort of rolls through our company. And then trying to make reasonable, not sand-bagging but not irresponsible projections about the future on a quarterly and an annual basis, it's really pretty challenging. So what we're confident in, as we look at backlog and we look at our selling and pricing strategies, is that margins can be nicely above in 2014 what they were in 2013. So ending at 20% for the full year, we feel pretty good about 21% plus during the year.

Now, the progression of that -- I feel actually pretty good that in Q1 and Q2 into Q3 we have a very good chance at year-over-year quarterly positive comps. But I would tell you that the margin for error on a sequential basis is sufficiently high that I get scared trying to make that forecast. So I don't know if that helps, but that's kind of how I am trying to do better at articulating this. And hopefully that gives you a little bit more to work with.

No. I appreciate that, Allan. And just a couple of technical questions. First, you mentioned that there was a little bit of additional expense in the SG&A that -- this quarter. I was wondering if you could break out the dollar amount there to get a sense of what the underlying SG&A was? Or more of the ongoing, let's say. And you also referred -- it might have been Bob that referred to the interest expense more being capitalized. With a view of roughly mid-teens revenue growth, I was hoping to get a sense of what the interest amortization expense could be, roughly, in 2014. I believe it was $41 million in 2013.

Okay. So I'm going to let Bob get all over interest expense. He's excited to talk about that. Let me talk about G&A for just a second. We settled and increased reserves on a couple of long standing construction warranty-related issues during the quarter. And I think a round number of about $3 million is appropriate. Those are non-recurring. And I think you can take those out when you think about run rates in G&A.

Great.

All right. So Bob?

So, Michael, the fun topic of capitalized interest. If you think about this year and really if you benchmark us to our peers, we have spent somewhere in 80% to 90% range of total cash interest expense. And remember with our issuance of our 2021 notes late September, our cash interest expense is going to go up to about 120 next year. So I think the way to think about it with the continued spend in our inventory, as we grow the land base, to think about next year being somewhere in the 80% range of the cash interest expense that will hit the income statement.

So I think just to clarify, Mike you're talking about cap interest in cost of sales. And you know for us that's about $40 million, and last year there was about $60 million below the line. So our total cash --

Yes. It's that interest expense amortization in COGS that I was referring to.

Yes. I think the interest expense through COGS will probably be a slight bit lower next year based on the higher inventory levels that we project. And then below the line, as we talked about in the past, Mike, is kind of a mathematical equation a bit based on the inventory that we have with the debt.

Great. Thanks very much.

Our next question does come from David Goldberg of UBS. Your line is open.

Thanks. Morning, everybody. Congratulations. Great quarter.

Morning, David.

My first question, Allan, on the 2B-10 targets, now that you have achieved Path to Profitability now we have to hit you up on the 2B10 targets and giving you a hard time. So the community count growth that you're looking at, can I presume that that basically assumes over the timeframe that you think about implementing this and achieving it, the recovery remains relatively concentrated? And these are -- geographic footprint remains relatively concentrated in better locations, AB locations, however you want to define it? Such that that's what's driving most of the ASP growth? Is it concentration? And we're not really getting to more peripheral areas and more entry-level buyers with that?

You're absolutely right. First of all footprint is not changing. We like the markets we're in, we did the hard work during the downturn, we left markets we weren't very good at that or that we didn't think had a lot of potential. So we love our footprint. And we're growing in our footprint and our buyer profile is moving just a little bit. But it's basically the geographic mix between our existing footprint that's driving the ASP more than anything. There's a little more California, there's definitely more of the Mid-Atlantic. And frankly, the product that we are growing faster in both Florida and Texas is at higher prices than where we historically have been in some of our other markets. So the mix within the company is really what's driving that ASP.

Got it. And then just to make sure I understand. If the mortgage markets were to loosen a little bit more than where they are now, obviously we're very tight at this point -- but if we were to see a little bit of a loosening in the next couple of years, do you think that would change the 2B-10 targets, in terms of where you would project ASP to be?

Yes. I think if you loosen the mortgage market, it's the old -- more money chasing scarce goods, I think prices would move faster to the upside. And we would have to raise our EBITDA target.

Okay. That's really helpful. And then just as a quick follow-up here. When we look at the 2B10 targets, especially on the SG&A side, I understand we're kind of in an interim step, but how do you get to a 12% target versus a 10% target, closer to where it's been historically? How do you get that interim step? How do you kind of get your hands around that's the right place to be in the interim?

Well, honestly when you're thinking about an interim step, the ability to communicate clearly becomes crucial So the precision of 10% as an EBITDA margin arrived at by subtracting SG&A from a gross margin, we sort of looked at both parts and said, how do we get from 13.5% to 12%? We need to grow revenue for sure. And we've got to be unbelievably careful with the dollar increases in G&A, that they are moving forward at a much lower pace than any revenue growth. And as we rolled it out and looked at different scenarios of future closings and different mixes of closings, I think we can get there. Let me be clear we're not going to get there in fiscal 2014 in one step. But I think we'll take a pretty big bite at that this year.

That's great. Congratulations again. Looking forward to more progress as we go forward.

Alright. And thank you for being the first one to repeat 2B-10 publicly. I appreciate it.

I didn't say schmuck factor, so you know.

Well, schmuck factor applies to us a lot, so we prefer 2B-10.

I like it.

Our next question does come from Dan Oppenheim of Credit Suisse. Your line is open.

Morning. This is actually Mike Dahl on for Dan.

Morning, Mike.

Morning. Allan, I actually wanted to follow up your comment on the changing mix within your geographic footprint. And just ask kind of a different way. As far as your 2014 targeted land spend, how are you thinking about capital allocation, geographically or by product type?

Great question. Product type looks a lot like our current product type. Really not a change there. And frankly the 2013 and the 2014 allocation is also quite similar. I think our 2013 numbers will show that we spent about 70% in four principal areas; California, Texas, Florida and the Mid-Atlantic. And I anticipate our fiscal 2014 spend will be very similar to that. Now, the mix within those is going to reflect clearly the availability of deals that meat our criteria. But if we ended up at the epidemic of the year with between two-thirds and three-quarters of our capital incrementally invested in California, Texas, Florida and the Mid-Atlantic, I would be very happy.

Okay. Thanks. And then just thinking about your here, could you break down what is -- at this point, what's legacy, what's newly identified and what are the close-outs scheduled for next year versus the openings?

Yes. I -- we don't have a great metric on that and it's not obstinence. I have got this whole, no community left behind mindset. Every community is an important community. And I kind of hate creating the excuse of it's an old one, it's a new one. We own it, we bought it, dammit we got run it right. And so I don't really think about it that way. What I can tell you is there about 50 communities that have 40 or fewer lots left that would be the likely group from which close-outs would occur based on a sales pace of three a month during the year. Some will sell faster than that, some will sell slower. So they're not all going to closeout. But that's kind of the solution set, 50 to 60, I believe, that have a lot unit count remaining that would kind of put them in that condition.

Okay. Thanks. And then quickly if I could follow up, since you brought it up; where do you stand on the no community left behind progress?

Well, we feel great. Our performing communities ratio is 90%, which is under 10% failing by NCLB list. And I have to say I'm really happy that that has been fully adopted into the culture. And people don't want to be on that list an so don't get on the list by making changes in real-time to stay off of it. I think that's one of the most important things that's happened in our company.

Great, thank you.

Our next question does come from Adam Rudiger of Wells Fargo Securities. Your line is open.

Hi. Thank you. I guess I will have to settle for a second on the 2B-10 question.

All right. There's a prize for second place, too, Adam.

Thank you. Looking at the targets for the gross margins there, the 2014 targeted range isn't significantly different than the 2B-10 range. And so I was just wondering what that -- if you think about -- I'm not asking for specific guidance, but the longer-term trajectories, land cost as it flows through the income statement, things like that. What's the multi-year trajectory for gross margins? We've heard different opinions from some of your competitors. So I was curious what yours was.

Yes. So I sort of punted here, to be honest. Because there are two things that are at play. One is what's going to happen home prices and what's going to happen to land prices. And we were in a period of time earlier this year where clearly land prices moved faster than home prices. And so if you're underwriting deals, you're looking forward saying, gosh that doesn't look like margin expansion. Market got a little softer in the Fall. If you were static in your view of home prices and land prices were either not appreciating or frankly coming back just a little bit, well, now all of a sudden, the prospects of deals in the future having slightly more margin pickup started to occur.

So rather than really guessing at both of those, what we have said is we're going to shot at 21% to 22% this year and we're going to make our model work, our 2B-10 targets on 22% Then if we get a situation where home prices move faster than land prices, we will he have an opportunity it take our next set of targets higher. Does that help?

I think so, yes. And then the other question I had was, if you, based upon your projected land spend for 2014, do you think you will be a net user or generate for of cash?

We're definitely going to use cash.

Use cash.

We're definitely going to use cash.

Okay. And then going back to one more gross margin question. You talked about earlier, before, the unpredictability on a sequential basis. That suggests you don't have a lot of visibility in your gross margins and backlog. Is that correct? Or it just a timing of closings that makes it confusing?

That's what happens. And when I say unpredictability -- it's been actually until this last year, of course -- it's been fairly commonplace that our Q4 margin was not the highest margin of the year. Well, it was in 2013. That was unusual. So when I say unpredictability, it's not so much that it is unpredictable and we're sitting 90 days out. As it is when I sit 90 days out trying to guess what's going to happen between 2Qs out, 3Qs out. And figuring out how the current selling environment does or doesn't fit the same pattern as in prior years.

Because very often, for example, we've seen a reduction between Q2 and Q3 margins. And that largely, historically, had to do with Houston and Indianapolis that were lower priced, lower margin communities for us having a larger share of their deliveries in that June quarter. That trend has changed a little bit as our mix geographically in the company is changing. And that's what makes it a little bit hard to do those sequentials.

Okay. And then if just lastly -- on that same topic then, going back to the original question asked on the call about October or September and some promotions and marketing, things like that; should we expect relatively stability in the December quarter?

Yes. I would be careful and, frankly, I would guide people away from growing Q4 forward. Because our target for the year is between 21% and 22%. But I feel very good we'll be up very nicely in Q1 compared to Q1 last year. And I think that will be true in Q2, as well. So we're going to have these year-over-year progressions. I'm a little worried about the -- worried, because I don't want to be wrong by 20 or 30 basis and then have everybody pulling their hair out if we post what's a great number but it was a few basis points lower than in the prior quarter.

Okay. Thank you.

Our next question does come from Jay McCanless of Sterne, Agee. Your line is open.

Good morning, everyone. First question I had, on the average backlog price that's been a double digits for three quarters in a row now, how sustainable is that growth trend? And how does that play into 2B-10?

Well, certainly a target in fiscal 2014 of $275,000 to $285,000 in ASP is hugely influenced by having a backlog around $270,000. And not influenced by having a fiscal year 2013 ASP of $250,000. So it plays a direct role. And we've had some slides in there, and they're in the appendix Jay, where you can kind of see at every quarter what the backlog ASP was and how that related to subsequent quarters delivery ASP. And there as pretty good correlation. So when we look at that and that's giving us confidence. Again, I think it reflects largely mixed shift for us among and between our communities in our markets. So I think it plays dramatically into fiscal 2014.

As we think about $300,000 as an ASP target as a part of 2B-10, I think that really reflects even further evolution of the capital allocation question. With 70% of our capital going into Texas, California, Florida and the Mid-Atlantic, that for us have higher prices than most of our other markets, that's dragging that ASP up. Not because we are, as I said, counting on price appreciation because we don't put that in our forecast, but because the mix shift is really reflecting now where we're putting our money.

Okay. Great. And the follow-up to that, tying on to the capital acquisition -- or capital deployment; with the two large land transactions we have seen in California over the last week, how does that influence your thinking about the spend you planned in that state? And could you maybe give us your take on those deals?

Well, I haven't studied them so I couldn't really speak about the deals. But I would tell you I happened to see one of them announce that they'd be selling $0.5 billion worth of assets as a result of the acquisition. And I can promise you I'll be on their email before the day is out, just making tour that if that takes place, that we're contacted. But we know who we are in California. We're not trying to be the absolute biggest. There are some markets, some corridors that we're very, very good in. And we've got a deep pipeline of prospects.

And I would tell you I don't feel like our opportunity set has been crowded out or reduced by those headline transactions. Those were owned by other builders yesterday, they're going to be owned by different builders tomorrow. In the meantime, they're opportunities that we pursue. And if something breaks loose as a results of one of those deals, that would be extra. That would be fine.

Okay. Great. Thanks.

Yes.

Our next question does come from Alex Barron of Housing Research Center. Your line is open.

Yes. Hi, guys. I was hoping to get a better handle -- I understand the margins are going to be up year-over-year, but given that market conditions are softer and the promotions -- what -- ? I guess two questions. One, what gives you the comfort that margins could increase sequentially into next year? Because it seems likes more builders are being more promotional and cutting prices and stuff. And second, what gives you the comfort that the sales pace could improve, given that the mortgage rates are higher than where they were at the first half of in year?

Well, let me take your second question first. When I think about our sales pace for the year -- we were, as you know, at about 2.9. And how we got there, just to kind of play back history -- here were our sales per community per month for the four quarters of fiscal 2013; 2.1 in Q1, 3.4 in Q2, 3.2 in Q3 and 3.0 in Q4. I think we can do better than 2.1 in Q1. I am counting on it. We're a different company a year later.

When we get into the spring selling season we will have a hard time, and in fact probably won't try and beat that 3.4. I said last year that that 3.4 was a little hotter than we expected, so we will probably be down a little there. And then next summer we're selling out of a larger mix of new communities, which will have lots of running room of pre-marketing for brand new product, if we can kind of sustain the sales paces on a sales per month that we had this year. That's how we would slightly move up that average. It really has to do with overcoming what we did in Q1 a year-ago. Okay?

Okay.

Al right. On the gross margin side I think -- it's not out of respect it's just because I got my hands full with our own company, so I don't spend too much time thinking about what other people are saying about gross margins. But I can tell you ours were lower than everybody else's for a long time. So for us to be moving up while they're moving down is not inconceivable.

Got it. Okay. Great. Thanks.

Our next he does come from Michael Kim of CRT Capital. Your line is open.

Hi. Good morning. Thanks for taking my question. Congratulations on the quarter. Really appreciate all the additional detail from your prepared remarks. First question is for Bob. Is the decision to tap the capital markets and free up that restricted cash in the balance sheet, what was the primarily driver behind that decision? Was it more opportunistic in light of conditions in the capital markets? Or really just driven by the land opportunities that you're seeing right now?

I think it was a little bit of both, Michael. There was an opportunity to tap the market for some longer-term capital at interesting rates. And we knew where we wanted to go with our land spend in the next year. We wanted to ensure that we had the capital to do it.

Yes. And is it fair to say that you're pretty much set with 2014 land and you are targeting 2015 and beyond? What's your target supply of land on hand for next year? Could we see something around like a six year supply of land or even something higher?

Well, the problem with that number is what's the numerator and what's the denominator, right? And we clearly hope to grow volumes in 15 and beyond by quite a bit. So I don't so much look at it on a year's basis. It also -- it's tricky because some of our markets -- and we would not be unique to this -- there's some markets where you've got to be in a five plus year context. There are other markets where you simply don't need to be. And so the mix of markets between builders makes that a bit of a tricky number. But I think your -- the first part of your question was exactly right. The land money that we're spending in 2014 is developing lots that are available in 2014 in the back half of the year. But it's really about being set up for 2015.

Okay. Great. And with the sizable cash balance now, does this change your strategy at all, in terms of the size of communities that you would look at for future acquisitions? Or does it kind of open up more opportunities for you guys to take a look at?

We've actually been in a pretty good spot from a liquidity standpoint intentionally for a long time. We shrunk the balance sheet a lot to hoard liquidity. But when we made land buys we weren't timid. And we've -- this year, for the first time in my memory at least, put out some press releases. Sot so much to affect the share price but to let people know the kind of things that we're doing.

And if you look at the Miramonte community that we bought in Dallas, or the Wincopia community that we bought in Maryland, or the River's Edge -- I just said it wrong -- River Village in California. Sorry to our California team. Those are pretty big deals. Those are eight-digit deals in each instance. So we've been willing to do some bigger deals. And the problem is -- the opportunity is we didn't chase small finished lot deals to juice unit activity in 2013 or 2014. We bought A plus assets that are going to year plus development timelines so that we could open up at the corner of Main and Main with a great asset. And its created this headwind of community count for us, but I'm completely convinced that lessons from the downturn include buy good dirt. Be in the right places. And you have to write bigger checks to do that. We're prepared to do that.

Understood. Alright. Great. Thank you very much and congratulations again.

Thanks, Michael.

Our next question does come from David Goldberg of UBS. Your line is open.

Thanks. I just wanted to ask a quick question I didn't get in before. And it has to do with the community count expectations, both for fiscal 2014 but then also in the 2B-10 target. And my question is, how much of the community count growth is really coming from the land banking arrangements? And do you have any assumptions about those expanding within your targets and within your numbers? Or is that just kind of based on the current what's rolling out of the land bank versus what's been put in?

So the 120 that Bob spoke to that was committed by the land banks would be a single-digit number of communities influencing 2014 and 2015, maybe a high single-digit kind of number. So it's not principally related to land banks. It's really, we've got control of our destiny with our own spending. So it's really incremental. And I don't want to say it's marginal but it clearly is a much, much smaller component of the community count growth in 2014. And I think that will be true as I part of 2B-10. as well.

Is there a chance it could be bigger? Is that just being conservative? Or that's just kind of how you see the land purchasing going, relative to the on balance sheet versus off balance sheet as we go?

This is going to sound borderline boastful. But what I would tell you, David, I don't feel capital constrained on our land spending right now. Between our balance sheet and the relationships that we've got, I think we have enormous firepower. What I feel constrained by are, do prices make sense? And do we have the mental, physical, man power, woman power capacity to underwrite, acquire, manage development and grand open successfully? I think that people part is a bigger restrictor on us right now than the capital.

Good point. Thank you.

Our last question does come from Joel Locker of FBN Securities. Your line is open.

Hi, guys. Just a question on gross margin. Obviously, improving. But just wondering if you had a pro forma gross margin on the land you purchased during the fourth quarter, assuming no current ASP and absorption rates and direct costs, going forward?

Yes. Very low 20's.

Very low 20s? So similar to what you guys reported. And that's pre-interest, right?

That is pre-interest.

Right.

And then the corporate expenses, you touched on, you said there was $3 million or so in one time fees, call it. So do you think a run-rate going forward is kind of around $33 million?

Yes. I think that's the right range. There will be a little pick-up as the community count expands. But we're still going to get revenue leverage out of it. But as a baseline, I think that's a better run-rate number.

And that's -- and the increase -- or the sequential increase of roughly $4 million, was that just maybe stock comp because you finally turning profitable? Or is it -- ?

I will be honest, Joel. I can't tell you the stock comp number in the quarter. It's not very material and I don't think it changed. I think really it was roughly $3 million in issues related to some legacy warranty stuff.

That was principally it, Joel.

I know. But I guess the total increase was around $7 million or 29 six to 36 four?

That's a little bit -- that's higher than -- I don't have actually that specific number in front of me. But I think it was about $4.5 million, Joel.

$4.5 million? All right. I didn't see the breakdown of the table you guys usually provide with the other things.

All right. It's in the back, I think, in the appendix, isn't it?

Okay. Well, Joel, feel free to call us. We're happy to go through every line in the G&A with you.

Will do. Thanks a lot.

All right.

That does conclude today's conference call. Thank you for attending. All participants may disconnect at this time.